If you’re a newcomer to investment, the notion of conducting research and finding bonds to buy may seem like a daunting one. Luckily, the whole process isn’t too complex, and all the jargon associated with the knowledge, terminology and risks associated with the bond markets is relatively accessible and straightforward for users to pick up.
The internet is awash with good, and bad, advice on how to approach the bond markets and interpret pre-existing information on what to buy and where to buy it. So with this in mind, let’s take a little impartial look at the best places to go to find the right bond to invest in – as well as taking a moment to remind ourselves of the key perks and drawbacks of bond investments:
How bonds work
By buying into a bond, you’re effectively lending money to its issuer for a specific period of time. In return, the issuer promises to make regular interest payments at an arranged rate until the bond becomes due – before repaying your principle upon maturity.
This may seem a little complex at first glance, so let’s break it down into an example. If you buy a 10 year £5,000 bond paying 3% interest, the issuer will in turn promise to pay you interest on your £5,000 every six months, and then return your £5,000 entirely after 10 years.
The example above is a general rule for bonds, but there are some exceptions. Zero-coupon bonds don’t pay interest but are typically sold below face value. But it remains that the majority of bonds follow a similar format, where a sum is invested and returned with a recurring rate of interest upon maturity.
Learning the different types of bond
When it comes to deciding the type of bonds that you would be best set to invest in, it’s important to consider the different types of bond available. There are a range of different bonds, all with specific benefits and drawbacks:
Corporate bonds, for example, are offered out by companies as a means of raising capital for pre-designated business operations, whether it relates to research, product development or scaling.
Corporate bonds traditionally offer higher interest rates, however, said interest is both taxable on state and federal levels.
Municipal bonds are primarily issued by US states, cities and local governments to help with the financing of public projects and services. This is a popular way of locally raising funds to begin the construction of infrastructure projects like new roads or transport hubs. Municipal bonds can come in one of two forms: general obligation or revenue.
General obligation bonds are supported by the credit of the issuer, while revenue bonds look to tap into the profits generated by the development of said projects. For example, if a local government issues revenue bonds in order to finance a sports stadium, proceeds will be issued back to bond holders.
Treasury bonds are government bonds that are issued by various governments across the world. The interest you receive from this type of bond is taxable at federal level but is exempt from local and state-level taxation.
Typically, treasury bonds carry a maturity of around a decade or longer in some cases and are backed by the faith and credit of their respective government. Because of this, treasury bonds are generally seen as risk-free investments. Although it’s worth noting that the associated interest rates aren’t nearly as high as with corporate bonds.
Finding the right bond to invest in
If you’re looking to get into the world of bond ownership, it’s best to take a look at where the experts are placing their trust for the future. In fact, the power of insights available for specific bonds can benefit even the most experienced investors.
Websites like Morningstar, in particular, offers an excellent star-based rating system that evaluates each bond on a scale of one-to-five stars. There are even plenty of lists on-site that rank the viability of each bond in order.
The world of bonds is a dynamic one, and as such it’s best to keep your ear to the ground. The most informed of investor is generally the best positioned to yield healthy profits, and platforms like MAXfunds, Lipper Leaders and Kiplinger Mutual Fund Finder are all excellent resources if you’re aiming to gain comprehensive insights and up-to-the-minute information on prospective investment opportunities.
Likewise, it’s imperative that you listen to multiple sources of information before investing. Sometimes mistakes and misleading reviews can lead investors into making rushed decisions over where their money is best placed. Before deciding to place your trust in a specific bond, be sure to consult multiple sources and make sure that they’re in agreement. Investing in an asset blind is an extremely risky way of managing your money – regardless of how promising a bond appears to be.
Before you decide to purchase a specific bond, it’s also very important that you compare prices for the best possible price offering. This form of investment game boils down to gaining the best deals per bond possible, and it’s vital to maximise your potential on this front.
Avoiding the pitfalls
Despite their promise, there are still plenty of pitfalls to steer clear of when purchasing bonds. Firstly, be mindful of reaching for too much yield. Even the most experienced of investors among us can make the mistake of buying only high-yield bonds.
While higher rates of interest are generally good, many high-yield bonds are considerably risky. As a rule of thumb, the higher the yield on offer, the more risky the investment will generally be. This means that if you build a portfolio that only consists of high-yield bonds, you may gain more interest but you run the risk of losing your initial investment if the issuer ends up declaring bankruptcy and is unable to return your money.
As with many investments, it’s imperative that you diversify your bonds. Make sure you don’t cause any overlaps with mutual funds by investing in different maturities – such as one-year, five-year, 10-year and 30-year bonds, as well as different fundamental bond types (see our earlier paragraph on investing on different types of bond). It’s also worth ensuring that the bonds you buy hail from different industries. Splitting your portfolio across financial, health and manufacturing industries helps to guarantee that no revenue streams could collapse simultaneously.
Referring back to an earlier point, failing to find the best-priced bonds can make for another significant drawback. To elaborate, bonds have ‘markup prices’ – meaning that they’re listed at the broker’s discretion to bring commissions into the overall price. It’s not mandatory that you pay the whole markup.
Bond prices can also be negotiable to an extent, and price fluctuations of 0.5% may not seem significant on the face of things but when you’re buying 1,000 bonds it can certainly help to expand your profit margins.
Is bond investing right for me?
One of the best things about investing in bonds is that they’re relatively secure investments. While there’s always a danger that issuers can go bankrupt, bonds won’t carry the same wild price fluctuations that stock prices suffer from – meaning that you’ll probably not be kept awake at night worrying if your investments are safe.
However, a significant drawback that may need reiteration is the fact that you’re locking significant volumes of money away for a long period of time. Investing in a 10-year bond may be a great way of ensuring some steady financial growth over the next decade, but what if something goes wrong and you need to access money three years into your investment?
Be sure to check your financial security before committing your money into bonds. If your situation is a stable one, buying into bonds can be the most rewarding and secure way of building a nest egg for the future.